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About this blog: I grew up in Los Angeles and moved to the area in 1963 when I started graduate school at Stanford. Nancy and I were married in 1977 and we lived for nearly 30 years in the Duveneck school area. Our children went to Paly. We moved ... (More)

About this blog: I grew up in Los Angeles and moved to the area in 1963 when I started graduate school at Stanford. Nancy and I were married in 1977 and we lived for nearly 30 years in the Duveneck school area. Our children went to Paly. We moved downtown in 2006 and enjoy being able to walk to activities. I do not drive and being downtown where I work and close to the CalTrain station and downtown amenities makes my life more independent. I have worked all my life as an economist focusing on the California economy. My work centers around two main activities. The first is helping regional planning agencies such as ABAG understand their long-term growth outlook. I do this for several regional planning agencies in northern, southern and central coast California. My other main activity is studying workforce trends and policy implications both as a professional and as a volunteer member of the NOVA (Silicon Valley) and state workforce boards. The title of the blog is Invest or Die and that is what I believe is the imperative for our local area, region, state and nation. That includes investing in people, in infrastructure and in making our communities great places to live and work. I served on the recent Palo Alto Infrastructure Commission. I also believe that our local and state economy benefits from being a welcoming community, which mostly we are a leader in, for people of all religions, sexual preferences and places of birth. (Hide)

Economy Blog #5: Are landlords greedy?

Uploaded: May 5, 2009

The issue of "greedy landlords" seems to a subject of great passion and interest on Town Square.

What follows is my economist perspective on the question of property owners, tenants and rents. Although I will use Palo Alto examples, this post is not personal to Palo Alto residents or property owners.

These are difficult economic times and I guess it is human nature to search for blame when we don't like what is happening. Is it possible, even more reasonable often, to talk about outcomes that we don't like without assessing blame?

For example, a rent decision that you don't like could be the result of rational behavior by the property owner, lack of full information on his or her part, or wishful thinking. I guess it is possible to characterize wishful thinking that didn't work out as "greed" but what then would you say about homeowners in Palo Alto who keep their homes listed at yesterday's prices. Are they greedy?

There are two parts to every transaction and if you think of the downtown Palo Alto rental market in 2000 (we have rented downtown for 40 years), it is easy to see that it was renters and not property owners who caused the big spike in rents that CCSCE got presented along with other downtown renters. In 1999 and 2000 there was a surge in venture capital start ups that wanted to locate in downtown Palo Alto. Rents would not have gone up if they had not pushed rents up by aggressively bidding for what they considered a prime location.

I find it hard to understand why people blame property owners when a bunch of folks playing with venture capital money bid rents up nearly 100 percent in some cases. Yet no one on Town Square mentions the companies. What were property owners supposed to do? Say, "No I absolutely won't go over $3 a square foot no matter what you offer me and, oh, by the way, I don't like that you are a high-tech start up playing with free money, I would rather rent to another cafe"?

Rents are primarily a function of demand. And when demand fell as companies went bankrupt or the funders told the start ups, "You bozos have to stop paying $8 a square foot on my dime to be close to neat cafes -- we are trying to run a company here," then rents fell.

So our rent went roughly from $3 to $5 and back to $3.

And after 2000 another wave of high-tech firms bought or rented space downtown. For them and for me downtown is an exciting and convenient area to do business. Our continuing interest pushed rents up above what you would find on other downtown areas. I am sure property owners were delighted when downtown became the place to be but property owners can't force companies to pay any rent. It is always a two-way negotiation.

Now we are seeing the downside of markets and rents.

The deep recession is turning the balance of power toward tenants as vacancies continue to increase in Palo Alto, throughout California and across the nation. Prices are falling throughout the economy as the recession forces sellers to sweeten the terms to reach buyers.

Rents are prices and while there may be exceptions I expect rents to continue to fall throughout the economy. That won't change the fact that downtown Palo Alto is a relatively attractive location for many activities or the fact that the relatively high rents in places like downtown Palo Alto make it difficult for some types of businesses to locate there.

Many of the comments about greedy landlords came up recently in a Town Square thread called Down Times.

One of the bad parts of asserting blame is that it pushes all of us away from the realization that we are, indeed, in "down times" caused by forces and misjudgments that are much broader than Palo Alto people and events. We are struggling with the human tragedy of economic down times and I, too, miss stores that our family loved.

But I think "down times" is the better explanation compared to greedy landlords. After all Palo Alto had no outlets for Mervyns, Circuit City, Gottschalks and the hundreds of other stores and chains that have disappeared as a result of their being not enough customers to support previous levels of economic activity.

Here is a list of layoff notices in California since November 2008. Look at the breadth of the pain across industries and cities.

Why is it that when we don't like the outcome, our instinct often is to look for blame rather than understanding? Can't bad outcomes just be, "That's the way it goes sometimes"?

So let's end with Palo Alto homeowners.

What are ethical homeowners supposed to do when they want to sell their houses? Is it wrong to think that homeowners who want to sell need the money for their family and future? Should they take $300,000 off the price because Palo Alto housing is so expensive? Should they ask potential buyers whether they own a "deserving small community-owned business" or work for a hedge fund and make their sales decisions this way?

If a homeowner engages in wishful thinking and keeps his or her home on the market for months because it is priced $500,000 above the market, are they greedy or foolish or maybe making a rational decision that the market can recover?

Posted by Paul Losch,
a resident of ,
on May 6, 2009 at 11:22 amPaul Losch is a registered user.

Steve,

This is such a touchy subject. I think a distinction needs to be drawn between ground level retail businesses and places such as Facebook or the like which do not depend on foot traffic for their sales.

I am not sure how landlords in town view the differences between the two, but as my beagle and I roam University Avenue on our regular walks, it is pretty clear that something is not right with downtown retail in Palo Alto. I just saw this morning that Gleim Jewelers is vacating its location shortly! They have been there for dozens of years. There are storefronts that have sat empty literally for years in downtown, and several businesses that have opened up there have last just a few years before closing down (Windy's, Neibaum-Coppola to name but two.)

Retail operations of various shapes and stripes do not enjoy the sorts of profit margins than do businesses that do not depend on their location for their success. By contrast, Danger Inc. was downtown for a while, and now they are in a building on Park Blvd near Fry's. No reason for them to remain downtown, as also is the case with Facebook, which I understand is re-locating.

When rents are too high, a retailer has a difficult time achieving success. It typically is one of the biggest expenses such companies have. With so much vacant space downtown, it suggests to me that the current asking rates are out of line with the market. It also becomes a downward spiral, as fewer people will patronize downtown as the retail offerings diminish.

Posted by Perspective,
a resident of ,
on May 6, 2009 at 11:44 amPerspective is a registered user.

Every financial transaction is, essentially, a bet, driven by an assessment by each party of the transaction concerning the risks, costs and benefits of the transaction.

Rationality, informed or not, and emotion enter into the bet.

A renter bets that s/he will make enough money to have the life s/he wants in the rented home/business, and decides the benefits of living/working in the place are worth the costs and commitment. A landlord makes the bet that the rent being paid by the renter is going to be paid, and is going to make the landlord enough money to have the life s/he wants, and is worth the risk of having to pay the mortgages, taxes and upkeep.

Emotion and knowledge enter into determining the outcome.

To "blame" anyone for deciding NOT to rent a business or a home is, as you implied, silly. There are many reasons businesses are choosing not to rent in Palo Alto, and they are quite valid, ranging from oppressive policies and ever rising taxes, high rents relative to return in sales etc.

Landlords not lowering the rent have choices in front of them. FEW businesses are willing to take a rental for just a year. Most want at least 10 year leases. Landlords are making a bet that if they wait a year or two, they will be able to rent their property at the higher rent...and lock it in for the next 10 years. If they rent at a lower rate now for 10 years or more, they are stuck. It is a bet.

It is true that when rents are "too high", retailers have a hard time achieving success..however, business rents on El Camino in Mountain View have been comparable to Palo Alto El Camino rents..yet they are rented and ours are not. Therefore, it is not simply rent that is the problem.

Posted by stephen levy,
a resident of ,
on May 6, 2009 at 1:40 pmstephen levy is a registered user.

I agree with Paul and Perspective that residents have strong feelings about the climate for business in Palo Alto. It is a separate but important issue from the discussion of property owner behavior and rent determination.

I can provide some data that do not provide an answer to the what should Palo Alto do questions but are interesting about downtown retail.

In the April 20th issue the Weekly on page 20 provided a table of retail sales in downtown. I have the statewide data and thought it would be informative to compare the growth rates.

In the 4th quarter of 2008 retail spending in downtown was down 16.4% from a year earlier while the statewide drop was 16.3%.

In every one of the previous 7 quarters the percent change in retail spending in downtown was greater than the statewide average--either more growth or smaller declines. I admit I was surprised.

Between Q1 of 2006 and Q4 of 2008 downtown retail sales were up 1.5% while statewide retail sales fell by 5.6%. I was even more surprised by these numbers. I don't know why the data are what they are or exactly what it means beyond the obvious point that downtown retail activity has not fallen off the planet compared to the rest of the state.

Posted by Carla,
a resident of ,
on May 6, 2009 at 1:59 pmCarla is a registered user.

Stephen is right that it is pure economics, and business. It takes two to make a deal, and business owners have to understand their numbers. They must plan for a good and bad economy situation, and they must be able to make ends meet in a bad economy. A bad economy by definition is one where sales drop 20% all of the sudden. This is the situation many business are in at the moment.

The reason that most business fail is that they don't understand their own business sector enough to understand the maximum that they should be paying rent. For restaurants it shouldn't be more than 9% or 10% of your revenues. The US average is more like 6%. These are limits, and yes there are many business that are so badly run that even if you control for rents; they can't make it because of other facts. A bad economy exposes everyone, the good ones and the bad ones.

Downtown Palo Alto is considered a luxury location by all measures, just like Beverly Hill and Key West. That is, many business are willing to supplant themselves here (and at the Stanford Shopping Center) sometimes at a loss because the upside is the high branding-visibility one gets from here. Therefore, it is not suitable for brand new business ideas and weak ideas.

Landlords have the right to charge whatever they want, but they too must understand the fundamental economics of the business that should go in; otherwise, their property will continue to be perceived as bad luck spot for entering business. It is for the benefit of both parties for rents to be reasonable.

The only 'greedy' landlords our there are those that are sitting on their properties for about 10 years, like 174 University Ave because no one in their right mind goes.

And yes, although, I hate to see Gleim Jewels out of business, the question remains: are they providing what Palo Altans really want today? Are there too many jewelry shops in downtown Palo Alto? Are they too becoming outdone with online competitions, like Amazon is doing to Borders. The economics change over time, and it is not necessarily the fault of the landlords. They take whatever they can get. And if an idiot business is willing to pay something they can't afford or a lease less than 5 years, that is not the fault of the landlord; that is business.

Posted by stephen levy,
a resident of ,
on May 7, 2009 at 4:03 pmstephen levy is a registered user.

Paul,

I hear what you are saying and I am sure many readers feel the challenges of how difficult it is for retail outlets.

My point is that rents are a market price for space. I am skeptical about saying that property owners are irrational in setting rents.
When there are lots of vacancies property owners here and everywhere make chocies about whether to lower the rent and for how long or whether to wait for the market demand to pick up.

The same is true for homeowners trying to sell in a lousy market. Should they lower the price or wait for an upturn?

The presumption is that both homeowners and landlords will make these calculations as best they can but I see no reason to question their ethics as other posters have done this year.

The issue that residents might like to have certain types of stores downtown that cannot afford downtown rents is a different question. What would you have property owners do? Comapnies and stores come and go all the time. They move or expand or go out of business.

The point of my post was to state the economist view that these are the result of two-party decisions (renters and property owners) and that the issue of "greed" seems misplaced to me.

Palo Alto is a complicated place and sometimes residents want low-price stores in high rent areas and lots of time residents want more shopping opportunities but no traffic. It is not unusual for people to have wishes that are in conflict (that was the point in my What are Voters Telling Us post). These are tough times but I think labeling other peoples' motives both is usually inaccurate and not helpful in making Palo Alto a better place.

Posted by Georgie Gleim,
a resident of ,
on May 8, 2009 at 11:21 pmGeorgie Gleim is a registered user.

I would like to make one correction to Carls's post; Gleim the Jeweler is not going out of business. We are merely closing our branch on University Avenue. Our Stanford Shopping Center and downtown Los Altos stores will remain open. Our decision is based on the fact that it is no longer making sense for us to have two fully-stocked retail stores as close together as are our Stanford and University Avenue stores, and we chose to close the one with the lower volume. We will relocate our accounting, appraisal, and estate buying offices elsewhere downtown, without the large retail showroom. We are not making this decision due to "greedy landlords." Our landlord has treated us very fairly for many decades. We simply recognize the fact that we need to adjust our business, as we have done many times since my grandfather opened it in 1931. As we conduct our store closing sale, many clients have shared their stories of what the jewelry they purchased from our store over the decades means to them, leading me to believe that we do hold a place of importance in the community.

Posted by pat,
a resident of ,
on May 9, 2009 at 11:34 ampat is a registered user.

How does this explain the sad fate of Caffe Verona? It's my understanding that the landlord bumped up the rate so significantly that Steve couldn't afford to stay. Then the space sat vacant for 3 or 4 years.

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